Is Silicon Valley in a bubble? It's complicated

Startups are finding it harder to get seed money, but that’s not necessarily a sign of a crunch

Published May 29, 2017 3:00PM (EDT)


To an outsider, Silicon Valley seems to exist in its own dimension, populated by self-aggrandizing visionaries who think the world can’t live without a $400 Wi-Fi-connected juicer or a vaping smartphone. This is a world where unprofitable companies like Uber and Tesla can rake in huge amounts of venture capital from investors placing long bets that companies will someday justify their current absurd valuations to become the next Apple, Facebook or Google. Outside observers might see this as a sign of Silicon Valley’s irrational exuberance.

Indeed, this massive influx of investment that’s been flowing into the tech industry in recent years is reflected in San Francisco’s skyrocketing home prices and the $100,000 luxury cars that glide down Interstate 280 between San Jose and San Francisco. The San Francisco skyline is being affected, too, as the tallest skyscraper west of the Mississippi River, $1.1 billion Salesforce Tower, is scheduled for completion sometime next year. (The completion of vanity projects like that has historically had an “unhealthy correlation” with economic busts.)

This past week alone Morgan Stanley estimated that Waymo, the self-driving car startup from Google owner Alphabet, could be worth a staggering $70 billion, or $20 billion more than General Motors, the world’s third-largest automaker that built and sold nearly 10 million vehicles last year. This is one of many tech industry valuation estimates that seem to be out of touch with reality. One of the more glaring examples is Tesla, a 14-year-old startup that’s deeply in debt but carries a $50 billion valuation. Tesla’s stock has jumped 43 percent since the start of the year, leading Tesla co-founder Elon Musk to declare his company’s stock price may be unwarranted.  

“I do believe this market cap is higher than we have any right to deserve,” he told The Guardian last week.

There’s no question that tech industry executives, company founders and highly paid computer engineers live in a cultural bubble. But is Silicon Valley itself experiencing a financial bubble?

The answer depends a lot on context.

“It doesn’t look like a bubble; it doesn’t smell like a bubble; it’s not a bubble,” Christopher Thornberg, co-founder of Beacon Economics, told Salon.

The former UCLA economist who studied the 1997-to-2001 tech industry busts said while some companies are earning sky-high estimates of their market value, overall investment activity is proceeding much more cautiously that it was 20 years ago.  

“Tech is where growth is right now,” he said. “Is it a little speculative? Maybe, but it’s nothing like it was in 1999.” And he added, “as long as businesses and consumers continue to buy the stuff San Francisco and San Jose is producing it doesn’t matter.”

Generally speaking, a bubble happens when there’s a rapid escalation in the price of assets followed by a rapid contraction that catches people off guard. The housing market crash after 2006 that caused the Great Recession is the most glaring example, along with the dot-com bust that peaked in 2000.

Jay Ritter, a professor of finance at the University of Florida who studies asset prices and company valuation, pointed to another important distinction: There is far less public money involved in speculative investments, and therefore the public stock markets are less exposed to the risks.

“In 1999-2000, many internet companies rushed to go public, and received very high valuations,” Ritter told Salon in an email. “Today, the high valuations are not going to startups, but instead to companies that have already demonstrated that they have been able to attract customers. I don't think that there is a bubble today.”

So if Silicon Valley isn’t in a financial bubble akin to 2001's, then what is causing so many stories in the media about a tech bubble?

The simplest answer it that since about 2013 venture capital began shoveling money at tech startups, but more recently entrepreneurs have gradually been finding fewer opportunities to acquire seed money, said Mark Dinan, founder of Dinan & Associates, a Palo Alto, California-based tech industry recruiter.

“Investors are taking a much harder look at business plans right now,” Dinan told Salon. “If three or four years ago you were able to get funding with hopes, dreams and aspirations, people are now looking at business plans and asking, ‘How are you going to make money?’ as opposed to ‘How are you going to get a lot of users and eyeballs?’ A lot of companies didn’t know how to make money and they were more focused on how to get acquired by Google or Facebook.”

The Bloomberg U.S. Startups Barometer, an index that essentially measures startup activity, shows that investment activity remains high by historical standards but has fallen about 40 percent since its peak in the summer of 2015.

Vikram Mansharamani, a Harvard lecturer and the author of “Boombustology: Spotting Financial Bubbles Before They Burst,” said defining what a bubble is can be difficult. But whatever the case may be in Silicon Valley, he said it’s becoming harder for investors to make money on the startup scene.

“There are lots of flashing warning signs that tells you nothing about the timing of a slowdown that could transpire, but it does tell you that probabilistically it feels riskier [to invest in technology startups] today than it has in a while,” Mansharamani told Salon.

So while Silicon Valley isn’t experiencing a bubble like the one it faced two decades ago, venture capitalists are starting to pull back and are paying more attention to how startups plan to actually make money on what they produce. In that sense, a bubble is deflating.

By Angelo Young

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